Inflation is Not Done with Us

Folks in America panicked when inflation rose to almost ten percent in 2021, the highest in over forty years. The Federal Reserve was considered to be way behind the curve in acting to slow inflation but reacted in 2022 by rapidly increasing the Fed Funds rate to 5.25% by July 2023. The higher rates seemed to curb inflation which has been slowly declining to under three percent currently, allowing the Fed to ease restrictive monetary policy by reducing the fed funds rate by 50 basis points (0.5%). A severe shock and plenty of political fodder for the upcoming election but the worst appears to be over. But is it?

The inflation we experienced was due to unique circumstances that are unlikely to be repeated. The Covid pandemic closed economies across the globe and panicked governments to shut down international supply lines creating shortages in many critical supplies including simple things like disposable face masks needed to fight the pandemic. In order to prevent a complete shutdown of the economy both the Trump and Biden administrations dumped vast amounts of money into the hands of consumers. With lots of money and no products to buy prices shot up. Many people blame Joe Biden and Kamala Harris because the inflation occurred under their watch, but inflation (and panic) was a worldwide phenomenon.

Everybody is breathing a sigh of relief now that the worst seems to be over and that the Fed appears to have a handle on inflation as it begins to lower interest rates to combat rising unemployment. But while the proximate causes of the recent spike in prices is unlikely to reoccur, the factors that had created decades of low inflation prior to the pandemic were also unique, and these factors are now disappearing in the aftermath of our recent troubles.

The collapse of the Soviet Union ushered in the so-called Washington Consensus epitomized by spreading democracy and free trade economics that expanded commerce and industry across the globe. This globalization of international trade was driven in large part by the rise of China as a manufacturing powerhouse but included many other nations as well, raising global standards of living to heights never seen before. The lives of billions were greatly improved. But the Washington Consensus wasn’t really a consensus. The Chinese Communist Party took seriously the advice of Deng Xiaoping to “hide our capacities and bide our time.”

The façade of China’s acceptance of the American rules-based world order that had so greatly benefitted China began to fray with the rise of Xi Jinping as leader of China. US President Donald Trump began to sound the alarm about China (although for the wrong reason). It took the Covid pandemic to expose the strategic error that the US had committed in allowing so much critical manufacturing capacity to relocate to Asia. When the pandemic struck the US could not produce enough respirators to take care of stricken citizens, nor could it supply enough protective gear for health care workers.

Inexpensive products imported from China and other poor countries around the world had kept prices low despite our profligate fiscal policies and ballooning public debt. Globalization was the escape valve for the unconscionable actions of our government. But while efficient global markets may have kept prices low, efficient markets are very fragile. The pandemic exposed our strategic vulnerability and clarified the fact that China was not a trusted trading partner but an adversary that had been gaming the rules-based system since the beginning. China now controls the supply of many of the raw materials necessary to keep our economy going such as lithium for car batteries and rare earth metals for microchips and smart phones.

Strategic necessity will require that we secure our vital supply lines. This will require re-shoring and friend-shoring a significant amount of our manufacturing needs. It will take years, maybe even decades to rebuild a robust economy that strengthens our strategic position and that of our friends and allies. Free trade economics provides the best progress and economic growth man has ever known but free trade requires a peaceful world. It requires a world where everybody transacts business by the same rules and cheating is punished and ostracized. But free trade is not the only policy dependent on a peaceful world. The Green New Deal weakens us strategically because trillions of dollars are being spent to replace existing energy infrastructure instead of increasing our energy infrastructure to meet the needs of a growing economy. Social justice programs do not increase our productive capacity. Our security in a dangerous world depends on the availability of reliable power and the capital to produce it.

The policies needed to guarantee our safety are far different from the lavish but unaffordable campaign promises made by both the Republican and Democratic candidates. Many people may be willing to pay more for products made in the US or by our allies, but re-shoring and friend-shoring combined with profligate deficit spending on non-existential social justice or tax expenditure policies is a recipe for increased inflation.

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If the changing global security situation means that we must change our economic relations it also means that we can no longer afford the profligate fiscal policies of the past. Six percent deficits and skyrocketing public debt do not enhance our security, especially if debts and deficits are directed to social welfare instead of defense or investment. Wealth transfer and social justice programs may increase demand for goods but it does not increase the ability to produce those goods thereby increasing inflationary pressures.

Both presidential candidates vow to fight inflation but if they actually follow through on their campaign promises prices will go through the roof. Mr. Trump offers trillions of tax cuts but counters that with a vow to increase tariffs. Tariffs are taxes and they are paid by the American people not only in higher prices for foreign goods, but also in higher prices for domestic goods protected by tariffs. Ms. Harris is literally promising to give money away by the trillions. Increasing the demand beyond the ability of the country to produce is a recipe for inflation. And the answer by both candidates for these amplified inflationary pressures, price controls. These candidates are trying to turn America into Argentina. That is, the Argentina that existed before the Argentine people threw out the Peronist regime and elected an economic libertarian, Javier Milei, as president. Mr. Milei is throwing out price controls that created shortages of many products but did little to stop inflation.

Both presidential candidates want to bring manufacturing jobs back to the United States to provide more opportunity for middle class Americans, a worthy goal. But import substitution, if not full-blown mercantilism as espoused by Mr. Trump, is a misguided way to strengthen our economy as I noted in my blog post, The Hallmarks of Mercantilism, published August 7, 2019. In that blog I stated that mercantilist countries “featured crony capitalism, rampant corruption, shoddy domestic products and extensive smuggling. They also featured excessively strong currencies protected by the high tariff barriers, capital flight and foreign borrowing to make up for the missing domestic capital.” These are not policies that will strengthen America. Plus they piss off friends and foes alike.

So the current policies espoused by both presidential candidates will doom America to higher inflation, huge deficits (whether from tax cuts or social welfare), and mounting public debt (along with enormous interest payments). These are not policies that will enhance our security in an increasingly more dangerous world. If these candidates truly want to get inflation under control they need to tell the truth to the American people, get our country’s fiscal house in order, and pay down the public debt.